Eric Tymoigne: “The fair price of bitcoins as measured by the discounted value of future cash flows is zero.”

Earlier today The Wall Street Journal posted two responses to the question: “Do Cryptocurrencies Such as Bitcoin Have a Future?”

The ‘Yes’ answer was penned by Campbell R. Harvey, a professor at Duke University.

The ‘No’ answer was penned by Eric Tymoigne an assistant professor at Lewis & Clark College.

I don’t fully agree with all of Tymoigne’s points, but I think the areas regarding speculative demand are empirically valid — he also has a couple other good, concise points that tie in with what Robert Sams has previously discussed (see Seigniorage Shares).

Below is Tymoigne’s full response:

“NO: As a Currency, Bitcoin Violates All the Rules of Finance”

By Eric Tymoigne

Bitcoins are an odd sort of commodity. They are not financial instruments. The value fluctuates widely, in line with changing views regarding the overall usefulness of the bitcoin payment system and the speculative manias surrounding such views. There is no financial logic behind bitcoins’ face value.

In other words, if you like to gamble, this is a perfect asset. If you are looking for an alternative monetary instrument, look elsewhere.

The bitcoin system has two components: the means of payment themselves, and an online ledger, called the block chain, which is a record of all bitcoins that have been created and who holds them. The ledger is the main innovation. It provides an open, decentralized, fast, cheap and supposedly secure means of completing transactions.

Volatile and Illiquid

But as an alleged alternative currency, bitcoin is unacceptable. Its volatility and lack of liquidity pose risks far beyond most traditional currencies.

To understand why, take a quick look at how real money works. Monetary instruments are securities. As such, they have a term to maturity (instantaneous) and an issuer—often a central bank or private banks—that promises to pay the bearer the full face value. Gold coins are a collateralized form of such security. Paper, cheap metal, and electronic entries are the forms such securities take today. The characteristics of these securities allow them to circulate at a stable nominal value (par) in the right financial infrastructure and as long as the creditworthiness of the issuer is strong. This provides a reliable means to complete transactions and, more important, service debts.

Bitcoins, meanwhile, violate all of the rules of finance. There is no central issuer guaranteeing payment at face value to the bearer; in fact, there is no underlying face value, and subsequently no imputed value at maturity, which means they are completely impractical for use in servicing of debt. The fair price of bitcoins as measured by the discounted value of future cash flows is zero.

Bitcoins pose a huge liquidity risk. Ultimately, anyone with bitcoins has to convert them into a national unit of account—dollars, say, or euros—to pay taxes or personal debts and to make other transactions. Their extreme volatility makes them a bad bet if one plans to buy a house in a few years, is saving for college, or has regular payments on, say, a mortgage or car. If bitcoins were a large asset in a portfolio, the investor’s solvency would be at risk. This certainly would be the case if bitcoins were promoted for poorer individuals who don’t have access to banking today.

Logic and Illogic

For an economy to work well, money needs to be created (for example, through bank credits or government spending) and withdrawn (through debt servicing and tax payments) following economic logic. We have all seen recently, in the global financial collapse of 2008-09, how irresponsible behavior on the part of big banks with regard to their lending and debt-servicing practices can set off widespread financial panic followed by years of economic stagnation.

The mechanics of creating and withdrawing money need to operate not only with sound economic logic. They also should be simple, to accommodate quickly the needs of a flexible economy. Today, money is created and destroyed in seconds through digital entries.

Bitcoins, by contrast, are created using a purely mathematical logic that lacks financial or economic underpinnings (currently 25 new bitcoins every 10 minutes); and they can’t be retired as needed to maintain their scarcity. Given the lack of economic logic behind the net injection of bitcoins, there is increased risk of financial and price instability.

The block chain is useful as an authentication tool and is the main innovation. But it’s too soon to tell whether it can have other applications. For now, unfortunately, it’s a potential step forward accompanied by an actual step backward.

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2 thoughts on “Eric Tymoigne: “The fair price of bitcoins as measured by the discounted value of future cash flows is zero.”

  1. >Bitcoins, meanwhile, violate all of the rules of finance.
    Tymoigne’s rules apply to finance, the world in which debt is paramount. Instead, according to the simple qualities of money, Bitcoin suffices.

    >There is no central issuer guaranteeing payment at face value to the bearer; in fact, there is no underlying face value, and subsequently no imputed value at maturity, which means they are completely impractical for use in servicing of debt.

    Bitcoin advocates would accept the argument and be thrilled. Debt causes the less than optimal allocation of capital in the boom and bust cycles that debt entails.

    >The fair price of bitcoins as measured by the discounted value of future cash flows is zero.

    This argument is not well founded, if one considers deflation of the currency token, as well as interest paid by a borrower on traditional fiat currency units.

  2. I have said this before, and I will say it again.. Bitcoin can work, but it isn’t going to right now. It is ahead of its time. It is not that people don’t want to use it or try it, they just don’t know about it. Paypal runs the online scene and banks still run the offline scene. Eventually, when everything is online, people will want everything merged for simplicity.

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